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Using Trusts to Minimise Tax :: Example 2

Reworked re previous gift by George

Note: This page refers to Using Trusts to Minimise Tax :: Example 1

George and Susan, circumstances are as described in Example 1 except George made a transfer to a discretionary trust in 2000 which, after deducting his annual IHT exemption, amounted to £50,000. Say the two let properties are valued at £290,000. All the other facts are as previously summarised in Example 1.

Susan's figures are not affected but George's gift in 2000 impacts upon the tax payable both on his gift into the settlement and the tax payable within George's settlement.

Tax Payable:

• at Nil rate: 285,000
• at 40%:     49,000

2006 IHT at lifetime rates : 9,800

Ten Years later

Tax Payable re trust assets derived from George at first ten-year anniversary 2016 – say, property settled by George now valued at £475,000. Say, Nil rate band 2016/17 £360,000

• £ 475,000+50,000 -360,000= 165,000 @20% = £33,000
• Effective £33,000/475,000 X 100 = 6.95%
• Actual rate 30/100 of 6.95 = 2.08%

IHT on 10th anniversary 2.08% of £475,000 = £9,880 (A)

IHT on George's death in 2017 Nil

(The trust does not cease on George's death)

Fifteen Years later

IHT on George's Trust ceasing on Susan's death in 2021 – exactly five years after 1st ten-year anniversary charge.

(Say, assets pass absolutely to surviving adult children on Susan's death when valued at, say, £600,000, with the children paying IHT. Say, holdover any capital gain under section 260 TCGA 1992 (re-starting taper relief clock.))

Tax payable (by beneficiaries) on trust cessation five years after previous ten-year charge calculated as follows. Say, Nil rate band 2021/22 £400,000.

• (recalculation) 475,000+50,000-400,000
  = 125,000 @20% = 25,000*
• Effective rate 25,000/475,000 X 100= 5.263 X 30/100= 1.57%
• Actual rate 1.57 x 20/40 = 0.789%

*recalculation of ten-year anniversary effective rate to reflect changes in IHT scale rates

• IHT on assets leaving trust 0.789% of £600,000 = £4,736.84(B)
• Total IHT re life of George's Trust (A) + (B) £14,616.84.
• Value of asset passing £600,000, therefore actual IHT rate 2.43%. SAVING 37.56% = £225,360.

Just one building? Watch gifts of fractional shares.

Say husband and wife own a building valued at £2,328,000 and it is assumed that a gift by each of a one-eight share of a building gives rise to a gift for IHT purposes of £291,000 – reduced to £285,000 by (i) the current year's annual exemption and (ii) the exemption carried forward from the immediately preceding year.

Problem? It is essential to calculated transfer of value for IHT purposes by comparing the value of their combined 100% interest in the building (related property rules dictate this) and then ascertain their combined interest in the retained interest.

The question is that one can usually demonstrate that, say in this case, the value of a 6/8th interest in a building is worth less than 6/8th of the value of the whole building. Commercially, let's say than the value is 85% of 6/8th of the value of a 100% interest the building.

The position becomes as follows:

Each spouse has made an immediately chargeable transfer of, given the assumptions made as to value, £130,950 more than anticipated. Lifetime IHT @ 20% in this example produces unexpected tax of £26,190 payable by each spouse!

Fragmentation of Trusts

Henry wishes to put £400,000 into discretionary trusts and is happy for an immediate IHT liability of £ 21,800 to be triggered. (£400,000 less £6,000 less £285,000 = £109,000 @ 20% = £21,800.)

Henry creates four so-called “pilot trusts” for £100 each on different days (so that they are not 'related settlements').

Subsequently, Henry pays £99,900 into each trust but on different days.

• The trusts are not related since they are created on different days
• As transfers made on the same day are ignored in computing the settlor's cumulative total, that total is either £100 or £200 or £300 when the relevant addition of capital is made.
• Each trust comprises £100,000.
• Each settlement will enjoy a full nil rate band – to cater for growth in value,
• the transfer of £400,000 into settlement will attract an immediate IHT charge at half rates.
• George and Susan should have done three settlements each, one for each child!!

Exit Charge

Section 65(1) imposes what is usually called an exit charge, that is, broadly, a charge on property which goes out of the discretionary trust. It applies in two types of circumstances:

1. where the settled property (or part of it) ceases to be 'relevant property', whether because
   1. it goes out of the settlement, or
   2. it stays in the settlement but becomes subject to an interest in possession or a 'favoured trust';
2. in other cases, where the trustees make a disposition reducing the value of the relevant property they hold.

See slides for example of Exits post the first 10-year anniversary. Exits in the first 10 years are outside today's talk which focuses on long term planning.

If there should be an exit in the first ten year period the IHT charge is calculated by reference to the chargeable transfers of the settlor before he settled the funds on trust and the initial value of the trust fund.

Say Henry made an ICLT to Discretionary to Trust 1 of £50,000 (£44,000 net of annual exemptions) three years before gifting £300,000 to Trust to on 7 December 2007. If the trust came to an end on 1 December 2017 at a time when the assets were worth £400,000 the position would be as follows;

Amount chargeable: £400000

Theoretically revise 10 years later:

Therefore effective rate becomes (revised tax as a percentage of entry value) = 1.33%

IHT Taxable on Exit (in first ten years) 30% of 1.33% but is further restricted to 39/40th thereof;

400,000 @1.33% x39/40 = £ 5187

Wider Trust Issues?

Don't forget that we are exploring the taxation issues today. Trust law as such in a vast topic and the earlier comments on trust issues barely scratch the surface. Support from a local knowledgeable solicitor is required.

The following two cases demonstrate some of the wider issues.

• Crowe v Appleby (51TC457)
• Saunders v Vautier 1841

Summary

As we have seen trusts will, if properly established, have their own Nil Rate Band and a settlor who has not made previous chargeable lifetime transfers can create a trust every 7 years to effectively create either an exempt or very low tax (IHT) vehicle to pass assets down to the next generation(s).

Yes one looses the benefit of the CGT uplift on death but this has to be seen in the overall context of the client's particular situation. The use of multiple trusts by each spouse over a long period - especially for non business assets, can be highly effective.